Commercial Real Estate Loans: How Do They Actually Work?
The world of commercial loans and real estates can become very complex. And just like any other types of loans, commercial real estate loans can lead to either success or a failure, depending on how one approaches the deal. So before making any huge step into an unfamiliar financial environment, take some time to review everything about the topic. In order to make better decisions (should you decide to make this kind of loan) and become familiar with the financial elements that come along with commercial real estate loans, below is a short summary of the things you will first need to know.
What are these loans?
Commercial real estate loans can be used to finance the purchase of, construction, or the development of a commercial property. Basically, the liens on the commercial property secure mortgages.
These types of loans serve as options for businesses (e.g. S corporations or companies with limited liability) to help them purchase commercial properties. Similar to home mortgages, commercial real estate loans are given by banks or private lenders. Aside from those entities, capital for commercial real estate can be given by insurance companies and even pension funds.
So, how do they work?
Unlike residential loans, commercial real estate loans work in the sense that they are generally intended to finance properties through which businesses operate. In order to qualify for this type of loan, (individual) borrowers have to establish a business entity. Aside from this, the borrower should also put a property to serve as a lien or collateral to help secure the request. If he/she failed to pay their mortgage, the bank or the lender can grab hold of the commercial property.
In commercial real estate, lenders normally check the potential income of the property to be loaned before approving the request. Hence, as a borrower, it is important that you polish your business plan as much as possible. Compared to residential mortgages, commercial real estate loans have their own set of risks.
However, lenders are encouraged by the income potential which can be generated by the commercial property. For instance, the property can be a hotel or a building that houses different businesses; in return, the lender anticipates a portion of that potential revenue to be used when paying back the loan.
Depending on the general state of the financial market economy and the type of loan the borrower selects, the interest rates on the property can differ. Generally, small businesses are charged with smaller rates, while larger ones have higher interest rates.
How do you apply for a commercial real estate loan?
With all the aforementioned facts, the idea of obtaining a commercial real estate loan can be daunting, especially for first-timers. But after spending some time to learn about how the process works, you will know that they are actually quite easy to process. After deciding to file (either as an individual or an entity), you need to evaluate your options and see what kind of loan will be best for you. You must also use a commercial mortgage calculator so that you can find the loan-to-value (LTV), and then measure the ability to service the debt using the debt service coverage ratio (DSCR).
